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Morningstar | Healthscope Divests Asian Pathology Business Largely as Expected; Maintaining FVE

We are maintaining our fair value estimate at AUD 2.40 for narrow-moat Healthscope following the sale of its Asian pathology assets to private-equity firm TPG for AUD 279 million. The sale of its Asian pathology operations in Singapore, Malaysia, and Vietnam was highly anticipated, given management’s well-flagged and ongoing strategic review. With divisional EBITDA of around AUD 18.2 million, or about 4% of group EBITDA, in fiscal 2017, these assets are relatively minor in the overall group. Nonetheless, the transaction represents an EBITDA multiple of 15.3 times fiscal 2017 EBITDA and a gain on book value of around AUD 165 million; as such, we think this a good deal and better than expected. The deal will also add to cash on hand in fiscal 2019, which can be redeployed in Healthscope’s brownfield expansion pipeline. After adjusting our forecasts for the sale of the Asian pathology assets, our EPS five-year CAGR is intact at around 8%. At current levels, Healthscope shares are screening as slightly undervalued. We think reflects market’s concerns over the private hospital trading environment and on-time delivery of the Northern Beaches Hospital, or NBH, Project.

Healthscope’s balance sheet remains stable, with all debt metrics, excluding NBH, remaining well under covenant requirements. Our modelling of the current debt levels, including NBH, generates year-end fiscal 2018 net debt/EBITDA levels of around 4.20 times. We see this trending down to 3.4 times by 2021. After adjusting for an expected capital payment by the NSW government of around AUD 400 million, upon opening of NBH in second-quarter 2019, this results in a net debt/EBITDA level of around 2.6 times by 2021, all else equal.

Following the divestment in fiscal 2019, we expect the hospital division to move to 90% of group revenue, from 88% previously, and increase revenue at a five-year CAGR of around 8%. This includes the uplift generated by the NBH, which management guided would deliver over AUD 300 million in additional revenue over a two-year period, or 12% of the fiscal 2020 expected AUD 2.5 billion revenue we forecast. While we still see challenges for Healthscope in the short term, given several underperforming assets in Victoria, which management is addressing by closure of Geelong Private Hospital and Cotham Private Hospital as announced in May 2018, we remain positive on progress made at NBH in Sydney, which continues to track on time and on budget, and expect it will open as scheduled in second-quarter 2019.